Fixed Exchange Rate

Fixed Exchange Rate. A fixed XR is where the central bank buys and sells the domestic currency to keep the XR at a fixed level.

A central bank can revalue the XR by using its foreign currency reserves to buy up more of the domestic currency so that the value of the domestic currency rises.

A central bank can devalue the XR by using domestic currency to buy foreign currency so that the value of the domestic currency falls.

A fixed XR creates stability, stability makes the future more certain so it is easier to plan and invest. A central bank could devalue its domestic currency to make the domestic currency more internationally price competitive so that the current account moves towards a surplus. However, if country A uses a fixed XR to gain international price competitiveness other countries could do the same in retaliation so that there is no change in global XRs. Moreover, a central bank cannot keep buying domestic currency with its foreign exchange reserves because eventually those reserves will deplete.